There has been much investigation over whether or not futures curves can accurately predict spot prices. In general, experts conclude that due to a varying number of factors, futures curves are generally not a good forecasting tool. The reasons are many, but the most relevant for Brent are as follows:
The effect of John Maynard Keynes’ ‘normal backwardation’ theory — which suggests forward prices will always tend to be discounted to the market’s expected future spot price to give investors an incentive to take on risk from producer hedgers. Therefore, even if the price is estimated correctly, the traded price will tend to under-state the market’s real price forecast.
Risk-adjusted premium, which is added in by traders to reflect the added risk of trading futures at any given time. This premium is a complex calculation, often subjective, but involving such factors as consumer sentiment, interest rates, and general economic health.
The curve fails to account for the ‘real’ inflation-adjusted value.
Source: Financial Times
However, in our past analysis, we discovered that compared to the EIA and internal IHS forecasts, futures curves outperform both consistently, up to the 12-18 month horizon from which we performed our analysis. In this analysis, we will dive deeper into the performance characteristics of Brent forward curves and examine accuracies on different forecast horizons and on differing points of the curve. This analysis is meant to help us gain a basic understanding of how the accuracy of futures curves may fluctuate over time, and sets us up nicely to analyze the curves on a risk-premium adjusted basis, which should theoretically yield higher accuracies.
It may be fruitful to preface our analysis with a nice visualization generated by Timera Energy - the progression of oil futures throughout the past decade. From this visualization, we can get a high level idea of the general trend of futures curves and their movement tendencies.
Progression of futures curves throughout the past decade